Introduction to

Applied Economics
3 Strands in the
Development of
Economics
1.Economics as
Study of
Wealth
- Economics as the science of
wealth-getting and wealth using
implies that the motivation of the
process of wealth accumulation is
the utilization of wealth for the
individual’s satisfaction and
society’s welfare.
Pertains to activities
answering the two major
economic problem in
any society-production
and consumption.
The intent of
producing goods
and services is
meant for
consumption.
Thus, Economics is all about
wealth and how this wealth
is being used by individuals
and society at large for
material survival, stability
and development.
2. Economics as Study of Making
Choices
In everything we do, whether we
produce or consume, whether it is
wealth-getting or wealth-using,
we make decisions and these
decisions are based on alternative
choices.
In the study of economics, when
we make a choice from among
these alternatives, it implies that
we are foregoing or sacrificing
the benefits that would've been
derived from alternatives that
were not selected.
Opportunity Cost
in everything that we
do, there are costs and
sacrifices that we have
to carry.
Opportunity Cost
in everything that we
do, there are costs and
sacrifices that we have
to carry.
In making decision, the
choice that we pursue
must be based on a
valuation of cost and
benefits.
This means that our choice
must give us additional
benefits that are at least
equal to or more than the
additional benefits derived
from the foregone
alternatives.
3. Economics as Study of
Allocation
Consistent with the process of
wealth-getting and wealth-
using and the process of
making choices is the process
of allocation.
- A social science that
deals with the study of
allocation of scarce
resources to answer the
unlimited human
wants.
 Five Elements in the
Definition of Economics
1.Social Science
2.Resources
3.Human wants
4.Scarcity
5.Allocation
Five Elements in the Definition of
Economics
1.Economics as Social Science
Economics pertains to the study of
how society creates its material
wealth, how it makes this wealth
available to its people with the
minimum difficulties, and how it
expands its wealth.
2. Resources and Study of
Economics
Resources or wealth can be
defined as products of nature,
qualities of individuals and
man-made things which are
used in producing goods or
services.
Three Types of
Resources
Natural Resources
Human Resources
Physical Resources or
Man-made Resources
 Natural Resources
 Marine resources drawn from the
wealth of oceans
 Timber obtained from forest
resources
 Agricultural lands that yield grains
and other food crops
 Mineral resources from mining sites
 Human Resources
-Qualities of human beings that may
include:
 Labor
 Intelligence
 Creativity
 Health
 Education
 Talents
Physical Resources or man-made
resources
 Various types of building
 Equipment
 Technology
 Bridges
 Airports
 Factory plants
 And other physical infrastructures
What are the key
characteristics of
resources?
Resources are limited. The
limitation of resources stems
from two major factors:
First, it pertains to the length
of time as well as the
difficulties in producing these
resources.
Second, the limitation
is further intensified
by the competing
uses for these
resources .
3. Human Wants and
Economic Analysis
Human Wants described
as differentiated or
expanded human needs.
Human needs can be
portrayed as basic
necessities for material
survival including food,
shelter, and clothing.
NEED WANT
S S
Wants
- the desires or wishes of
citizens.
-are a means of expressing
a perceived need.
-are broader than needs.
Human wants are based
on human needs, but
differentiated or
expanded by the
influence of various
factors:
- Level of income
- Environment
-are broader than needs.
Needs: These are basic
requirements for survival
like food and water and
shelter. In recent years we
have seen a perceived shift
of certain items from wants
to needs.
Scarcity as a Source of Economic Problem

- the fundamental economic problem

facing ALL societies. Essentially it is
how to satisfy unlimited
wants with limited resources.

- Occurs when resources are either

improperly allocated or are limited
relative to man’s needs and wants.
How do we conquer the issue of
scarcity?
 FACTORS OF
PRODUCTION
- are the different elements that contribute in the
production of people’s varying needs and wants.
 LAND
-A factor of production that covers all
natural resources that exists without
man’s intervention. It encompasses all
things derived from the forces of nature
such as air, water, forests, vegetation, etc.
 LABOR
O- refers to the human inputs/effort
used productively such as
manpower and skills that are used
in transforming other resources
into different products that meet
our needs.
 CAPITAL
O - isa man-made factor of
production that is used to create
another product . It consists of
those goods which are produced
by the economic system and are
used as inputs in the production of
further goods and services.
FUNCTIONS OF
CAPITAL
- provides equipments which help
in the process of economic
- determines. the quantity and also
development
the composition of output in the
economy.      
- helps in the creation of
employment opportunities in the
country.
 ENTREPRENEUR
O- resource which integrates land, labor
and capital to produce new products.
O - organizes production by bringing
together the other three factor of
production land, labor and capital.
 FUNCTIONS OF AN
ENTREPRENEUR 
• He conceives the idea of launching the project.    
• He mobilizes the resources for smooth running of the
project.
• The decision of what, where and how to produce goods
are taken by the entrepreneur.
• He undertakes the risks involved in production.
• He is an innovator. He innovates new techniques of
production, new products and brings improvements in
the quality of existing products. He is in fact the captain
of the industry.
 BASIC ECONOMIC
QUESTIONS
What to produce?

How to Produce?

For whom to Produce?

ACTIVITY : With the given
economic questions, determine
what is being referred to by the
following statements.
1. Consider production
possibilities and efficient
use of resources.
2. Technology, Human
Resources and both
3. Consider distribution of
income (rich v. poor)
 WHAT TO PRODUCE?
This is concerned with how we
allocate our scarce resources.
The society determines the kind
and quantity of products they
will be producing depending on
what the consumers want to buy
or willing to pay
 HOW TO PRODUCE?
O A society decides who will produce the
goods and what process of production
will be used.A good maybe produced by
corporations, by small business owners
or by the government itself. The
process of producing a good maybe
addressed depending on the costs and
availability of resources needed.
 FOR WHOM TO PRODUCE?
O All goods and services are produced for
somebody to consume. The question of for
whom goods will be distributed revolves around
the issue of who will benefit from the goods and
services.This depends on the distribution of
wealth in a particular society. Therefore, a
consumer who has the capacity to pay for
certain goods and services is more likely to
benefit than those who could not afford them.
 THE ECONOMIC SYSTEM
Economic system is characterized by the type of institutions
responsible for the management and allocation of resources used in
the production of goods and services.

1.Market economic system

2.Command economic system
3.Mixed economic system
COMMAND ECONOMIC SYSTEM
The state or an agency of the government may be in
charge in the allocation of resources by using its
political power in answering the basic economic
problems of production and distribution.

The command system has been useful as a temporary

alternative mechanism in abnormal times when the
market system cannot fully operate or the price of
mechanism is inadequate for allocation
O What to Produce – is answered by producing more
public goods like roads, public schools and hospitals.

O How to Produce – answered by employing all possible

laborers using available machinery and equipment.

O For whom to Produce – answered by the govt. such

that production should be for the public.
Great Leap Forward
Used during the leadership of Mao-Tse-tung in China
This program hasten the industrialization of the country
by increasing the production of industrial goods at the
expense of agricultural commodities.

How they will generate savings to finance

industrialization program?
 MARKET ECONOMIC
SYSTEM
O What to Produce – answered by producing
goods that yield high profits.
O How to Produce – answered by producing at
“constant returns to scale”, with minimum
cost.
O For whom to Produce – answered by
distributing the goods to all those who can
afford to buy them.
 MIXED ECONOMIC
SYSTEM
O The questions “What to Produce?”, “How to
Produce?”, and “For whom to Produce?” are
answered by both the government and private
entities benefiting both.
Traditional Economic System
The use of tradition may be useful in situations where the
operation of the market may not be appropriate, or the
power of an organized state has no control over a
certain community.

The tempering mechanism of tradition is made through

the formation of simple human wants which are shaped
by social norms and values.
 OPPORTUNITY COST
O - The alternative uses for your money and time
an opportunity cost is incurred every time you
use your money and time to do something.
O - is the highest value of something that we are
prepared to lose to gain something that we
value more.
EXAMPLES :

1.The opportunity cost of going to college is the

money you would have earned if you worked
instead. On the one hand, you lose four years of
salary while getting your degree; on the other hand,
you hope to earn more during your career, thanks to
your education, to offset the lost wages.

2. When you choose to use your money to buy

movie ticket, you give up the opportunity to buy
something else that you value, when you choose to
use your time to see a movie you give up the
opportunity to do something else that you value.
EXAMPLES:
3. The cost of a soda drink is P25.00. The
opportunity cost of buying it corresponds to all
the other items that can be bought with the same
amount.

4. You will ask about the value of time you will

give up when you take the boat as well as the
value of the money you give up when you decide
to take the plane
 TRADE OFF 
Situations in which they have to choose
between two things that cannot be had at the
same time.
Ex. Do I buy new dress or two new shirts.
Do we go to Baguio for vacation or Boracay.

Trade off is often described as

sacrificing something to gain something.
 Trade off
Example:
1.If you are watching an important live
telecast, you have to miss your regular
favorite program which means that you
are trading off your favorite program for
this important telecast.
EXAMPLE: Opportunity Cost
3. For a person going to a basketball
game, their opportunity cost is the
money and time expended, as
compared with the alternative of
watching a particular television
program at home
 Opportunity Cost vs Trade Off

• Trade off and opportunity cost are two concepts

that are made use of in many situations in life.

• Though similar in meaning, trade off is

sacrificing one thing to get another while
opportunity cost is the cost incurred by losing out
on one thing to get another.
 Opportunity Cost vs Trade Off

A trade-off describes what you sacrifice

to get something else while opportunity cost
refers to what you could have done with what
was given up.
EXAMPLE:
Somebody skips school to go see a
basketball game. The trade-off is giving up school
for seeing the game. Opportunity cost refers to
what was given up, i.e. grades would not have
suffered had the person in question not skipped
school. This opportunity was given up by the
person. 
Trade-off simply means sacrificing what you have to get
something else.
Opportunity Cost refers to comparing cost and benefits
of alternative choices 
1. A person may choose to sleep rather than going to
class. That is Trade -Off 
2. Shoes and bags, a person may prefer shoes more than
bags because the cost is affordable and also of higher
quality.
Economics as an Applied Science

Several application in commercial sciences

1. In the field of accountancy, the information generated
in the recording and analysis of transactions on the state
of assets can be useful in making business decisions.
2. In marketing, understanding the behavior of consumers
can be useful to firms in expanding their market share.
3. In finance, the formation of excess funds for
investment purposes can be understood through the
concept of savings.

4. In management, the optimal combination of human and

physical resources to be used in production will require
understanding of benefit and cost expressed in terms of
factor productivities and factor prices.
 Framework in Understanding Decision
Using Economic Analysis

This structure is based on the analysis of benefits and cost

in decision-making.

What are your motivators or drive factors in making

decisions?
In making decision, economic and otherwise, an
individual is influenced by a number of
motivators. Pursuing any choice implies that
there are cost accompanying the benefits arising
from his behavior.

This cost can be expressed in terms of money,

time, resources and other goods and activities
being sacrifice or forgone.
In making any decision, we have to weigh and
compare the benefits and the cost incurred, the
benefits should be positive and as much as possible
will yield the highest net returns.

These net benefits may expressed in terms of surplus,

net satisfaction, net returns, or profit depending on
the decision maker.
Since the decision made is always prospective, what
important is not the absolute value of benefits and costs
but the additional or marginal benefits and marginal
cost.

Marginal benefit
The additional derived from additional activity

Marginal cost
The cost incurred from additional production of good or
service.
The marginal analysis of benefits and costs is also useful
in setting the condition for an optimal decision.

In economic analysis the condition for the attainment of

maximum net benefits is set when the marginal benefits
is equal to marginal cost
MB > MC Net MB positive Total Net Benefit
Increasing

MB < MC Net MB negative Total Net Benefit

Decreasing

MB = MC Net MB zero Total Net Benefit

maximum
The condition of attaining maximum net benefit may
appear very simple, this straightforward equation is
altered by many factors.

These differentiating factors may be the source of

economic and business problems including excess
consumption, inadequate investment, unemployment,
excess production etc.
 Variations in Benefits and Costs
Due to Stage Recognition

Explicit costs
Cost than can be measured in monetary terms or levels of
disutility.

They are easily recognized since they are expressed in

monetary terms and may involve actual financial
outlays.
Recognition of implicit costs is more difficult since the
decision maker does not have to incur any monetary
expense.

Implicit cost is opportunity cost, which is a basic

concept in economics.

Example:
Sample Accounting and Economic Profit
Businessman who own a building
Benefits of elementary education
Spatial Dimensions in the Issue of Recognition

Implicit benefits and costs are harder to recognize

because of the spatial consideration of the decision
maker.

The implicit benefits and costs are hidden from the

individual because the level of his awareness on the
benefit and costs of his decision are more
pronounced on private benefits and costs.
Social benefits and social costs are not internalized by the
individual decision maker. These social benefits are spill
over effects of individual decisions that the entire
community may enjoy.
Example:
A firm contemplating on the construction of a major road
project.

Social costs are spill over effects of individual decisions that

put a burden on the community at large.

Example:
A firm disposing its production wastes.
Temporal Dimension in the Issue of Recognition

The temporal dimension of a decision-making process can

also contribute to the non recognition of implicit cost.
An individual action is decided on the basis benefits
and present costs.

Present benefits and present costs are readily realized

while future benefits and future costs are too distant in
time to affect the awareness of the decision maker.
Example: Immunization of a children, people engage in
over fishing and excessive logging (future cost)
 Variations in Benefits and Costs Due to
Differences in Valuation

Even if the decision maker recognizes the implicit benefits

and implicit cost of his action, the differences between
marginal benefits and marginal cost can still persist.

The proper pricing and valuation of these implicit costs may

have an effect on the optimal decision.

Example:
School attendance of children from poor families
Spatial Dimension in the Issue of Valuation

The valuation of implicit cost may also differ because of

spatial considerations. Even if the decision maker has
recognized the social benefits and social costs of his
action, various individuals may have different valuation
of the social impacts.

Example:
Firm doing a research (private scheme)
Traders sells defective fireworks
Temporal Dimension in the Issue of Valuation

The issue of valuation can also effect the temporal

dimension of benefits and costs. Because present
benefits are currently and directly enjoyed by the
decision maker, they are more significant and have
higher values than benefits that are yet to be realized
and enjoyed in the distant future.

Discount rate is rate which stream of future values is

reduced to make them comparable with present values.
This concept of discount rate on the valuation of
future benefits can explain why some people buy
insurance more than the others.

The valuation of future cost in terms of discount rates

may explain the differences in the behavior of
individuals. Take the case of smoking.